Google's Lenovo Buy Just Temporary

Media have been buzzing these last few days about a Hong Kong stock exchange filing revealing that Google (Nasdaq: GOOG) has acquired 6 percent of Chinese PC giant Lenovo (OTCPK:LNVGY, HKEx: 992), implying the deal represents a vote of confidence by the world's biggest Internet company in the world's top PC seller. But anyone with any memory will recall that the transaction is just part of Lenovo's payment for its recent purchase of Google's Motorola cellphone division. What's more, Google is almost certain to dump the stock once a lock-up period ends, putting pressure on Lenovo's stock until that date arrives.

Lenovo is no stranger to using its stock to finance some of its largest purchases. It financed its landmark acquisition of IBM's (NYSE: IBM) PC business in 2005 partly with its stock, and also used its shares in a joint venture that saw it take over NEC's (Tokyo: 6701) PC division in 2011. In both cases, IBM and NEC sold most or all of their Lenovo stake almost immediately after the lock-up period ended or even sooner, typically 1 to 2 years after the initial sale. There's no reason to think that this time will be any different, following Lenovo's announcement 2 weeks ago that it will purchase Motorola from Google for $2.9 billion.

Lenovo's shares have come under steady pressure since announcement of the Motorola deal, sinking more than 20 percent since the purchase was announced. The shares were trading at their highest levels in more than a decade after the company separately announced earlier in the month that it would buy IBM's low-end server business for $2.3 billion, a deal that had been rumored for much of the past year and one that many saw as a positive development for Lenovo.

Let's look quickly at the latest headlines, which say that Google has formally acquired a 5.94 percent stake in Lenovo with a market value of $750 million (English article). Under that deal, Google is getting 618.3 million Lenovo shares at a value of $1.213 per share, roughly translating to HK$9.44 per share. That level is well above Lenovo's last closing price of HK$8.42, meaning Google's stake has already lost 12 percent of its value and is now worth just HK$5.2 billion, or about $667 million.

When they first announced their deal, the the pair said Lenovo would purchase Motorola using $660 million in cash, $750 million in shares, and another $1.5 billion in the form of a 3 year promissory note (previous post). Lenovo was able to use its stock as part of the sale because it knew that Google was keen to get rid of Motorola, a former cellphone giant whose star had already faded considerably when Google purchased the company for $12.5 billion in 2012.

Lenovo's shares started to come under pressure after the Motorola deal was first announced at the end of January, as investors fretted the Chinese company might be taking on more than it could comfortably handle with 2 such major purchases whose businesses were declining. The shares came under further pressure last week when reports emerged that the company might be in talks to take over the Vaio PC unit of Sony (SNE, Tokyo: 6753), as part of a retrenchment by struggling Japanese consumer electronics giant.

All of this brings us back to the question of what's ahead for Lenovo's stock after this latest series of deals. Some readers may recall that Lenovo's shares briefly tumbled in September 2012 after NEC sold shares it received as part of the pair's PC joint venture deal. But the shares quickly bounced back after that, as they were absorbed into the market. Obviously Lenovo's management of these 2 major new acquisitions will be the biggest factor influencing its share price over the next 2 years; but threat of a major Google share sale will certainly create downward pressure during that time, and I would expect the company's stock to trade sideways or move downward during that period.

Bottom line: Lenovo's shares are likely to trade sideways to downward over the next 2 years, due to pressure from 2 major new acquisitions and the likelihood of a major share sale by Google.